Since 2010 Britain has been a laboratory for an important experiment in economic policy. The question: When economies slump and public borrowing soars, can fiscal restraint speed the recovery? Preliminary findings: No, and whatever made you think it could?
The unemployed weren’t asked whether it was all right with them, but Britain was a good place for the experiment. For a start, its government actually controls fiscal policy. On Wednesday, Finance Minister George Osborne will set out his new budget in the House of Commons and, strange as it seems in Washington, that will be that. Osborne won’t call for Parliament to change tax rates or urge it (perhaps seriously, perhaps not) to do one thing or another. He will set policy, period.
As a place for this test, Britain had another advantage. Like the U.S. but unlike France or Germany, it has its own currency and runs its own monetary policy. Osborne doesn’t have to frame his budgets knowing, as governments in the euro area know, that interest rates will be set somewhere else according to somebody else’s needs.
Britain therefore had a lot of freedom to get fiscal policy right when the recession bore down in 2008. The Labour government then in power let automatic fiscal stabilizers work unimpeded and added a moderate amount of discretionary stimulus on top. Public borrowing surged. The Treasury said it was suspending its fiscal-policy rules until the economy was back at full strength.
In opposition, the Conservatives called this reckless. When they came to power in 2010, they announced a sharp break. To help restore financial confidence, the government would tighten fiscal policy at once. The idea was that austerity, done correctly, would promote growth. It would remove the threat of fiscal collapse. With public borrowing in check and confidence improved, the private sector would take up the slack.
It didn’t happen. Britain’s households aren’t spending, and its businesses, despite running big financial surpluses, aren’t investing. For the past 18 months output has been essentially flat, still well below its level when the recession began. Official forecasters think output won’t regain its 2008 level until 2014 -- a slower pace of recovery than Britain experienced after the Great Depression.
In one way, the figures flatter the Tories’ fiscal experiment, because the Bank of England has been more forceful than the Federal Reserve in supporting the economy with quantitative easing (where the central bank buys debt to increase the money supply). The Bank of England persisted in this approach despite high inflation, which peaked at more than 5 percent last year, against the Bank’s official target of 2 percent. Without such aggressive loosening of monetary policy, the economy would be in even worse trouble.
Together, though, monetary and fiscal policy are still doing too little to support demand. Inflation has fallen in recent months and, according to the Bank, is on track to drop below the 2 percent target. Some of last year’s inflation surge was due to an increase in value added tax, which will drop out of the numbers. Expectations of inflation have stayed well under control -- a tribute to the Bank’s ability to explain itself -- and, crucially, with unemployment still very high, there’s no sign of wage inflation.
The Bank can do more QE if need be, but looser fiscal policy can and should be part of the mix. Unfortunately, the government is unlikely to admit its mistake and concede that fiscal policy has been too tight. The budget is about politics as well as economics, and one of Osborne’s tasks on Wednesday will be to divert attention from that larger issue.
So expect the usual bundle of tweaks to the tax system. The Tories and their coalition partners have been arguing about whether to trim the highest marginal rate of income tax, currently 50 percent, to curb tax avoidance. This might be done alongside a new rule to set a minimum overall tax for the rich - - akin to the Buffett rule that the Obama administration has proposed for the U.S. -- and higher taxes on the sale of expensive houses. The Treasury has also been trailing measures to spur corporate investment and a new initiative on privately financed infrastructure spending.
There’ll be no great change in the overall course of fiscal policy. By making far too big a deal of it in 2010, the government locked itself into “austerity is unavoidable.” This line, carried to excess, not only limits the scope for necessary short-term fiscal easing but can also undermine longer-term fiscal control. Indeed, the government’s new hopes for privately financed infrastructure are a classic case in point.
The idea is to get private companies to build new roads and recover the costs later through tolls or other fees. In principle, charging users for infrastructure is a fine idea -- especially if congestion pricing is used to restrict peak demand. But it’s crazy to finance what is public investment in all but name through private borrowing when the government can borrow long-term for almost nothing. Britain does need to spend more on infrastructure. Now is the perfect time to finance this through higher public borrowing. Not only would it spur demand, but in the end it would cost much less.
Criticism of David Cameron’s government from Labour and its allies on the left is overdone. The fiscal tightening after 2010 wasn’t as sudden or severe as they say. Cameron invited this line of attack by portraying his change of policy as brave and radical. Britain still has a big budget deficit and rising public debt. The Tories are right that longer-term fiscal consolidation is necessary: Public debt cannot rise without limit, even for a country that can print its own currency. And it’s not easy for a government to commit itself credibly to “austerity tomorrow” without making some kind of down payment.
Nonetheless, a milder and longer-delayed fiscal adjustment than the one Cameron and Osborne devised was possible, and would have been smarter. A less boastful presentation of the policy when the Tories took office would have made later midcourse correction easier, and it would have been less apt to steer policy toward private financing of public investment and other fiscal absurdities. British governments have a lot of flexibility in their conduct of fiscal policy. They should conserve it, so they have it when they need it.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
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